Why it’s nearly impossible to trade Currencies with success

(Elite E Services) — 9/1/2017 — As we have explained in our book Splitting Pennies – trading FX is nearly impossible; or at least, it may be possible for some time, but in the long run, it’s a near certainty that without the use of professional algorithmic trading systems you will blow up your account. That’s because of the dynamics of how FX works vs. other markets. In traditional markets, there is a bias towards positive movement; all CEOs of public companies want their stock to go higher. Bull traders, 401k investors, pension funds – basically everyone wants the stock market to go up. The short sellers aren’t ‘pessimists’ so much as ‘realists’ that over-inflated P/E ratios are a sign for a crash from unrealistic levels. This is NOT the case in FX. Currency markets have opposing forces like ‘gravity’ and ‘anti-gravity’ – every country wants both a strong currency and a weak currency. This may seem illogical, welcome to the world of Currency! The reason is simple – exporters want a cheap currency and importers want a strong currency. Politicians usually favor a weak currency because it’s good domestically and big business favors a strong currency (at least in the USA) because USA is a net importer. Let’s have a look at today’s USD action most noticed in EUR/USD:

On the surface this looks like a great trading opportunity – but is it? EUR went up on poor US Payroll data; and then fell on dovish jawboning from the ECB. Planned conspiracy to manipulate FX or just random brownian movement? Believe what fits into your mind that helps you sleep at night, either way – would you have been able to buy EUR at 1.1924, sell near the high at 1.1980 and then reverse, covering near 1.19 handle? All within 10 minutes? Maybe someone did it, even if by accident, but the point is that any trading plan or investment strategy shouldn’t rely on the ability of such skills because even if as a trader you were able to achieve this great feat – would it be able to repeat it, day in and day out – for years? Probably not.

The Triffin dilemma or Triffin paradox is the conflict of economic interests that arises between short-term domestic and long-term international objectives for countries whose currencies serve as global reserve currencies. This dilemma was first identified in a 1929 book, Gold and Central Banks, by Polish economist Feliks Młynarski,[1] who identified a fundamental instability in a gold-based international monetary system, that the reserve currency countries would tend to accumulate foreign reserves, but as the volume of these grew relative to the country’s gold reserves, international investors would begin to fear suspension of convertibility; later in the 1960s, it was rediscovered in the context of the Bretton Woods system by Belgian–American economist Robert Triffin, who pointed out that the country whose currency, being the global reserve currency, foreign nations wish to hold, must be willing to supply the world with an extra supply of its currency to fulfill world demand for these foreign exchange reserves, thus leading to a trade deficit. Due to Młynarski’s precedence in articulating the problem, Barry Eichengreen has suggested renaming the problem to “the Młynarski dilemma“.[1]

This is not only true for a reserve currency – any currency has a conflict between short term and long term interests. For example, if a currency is weaker it can help exporters in the short term to boost sales, but hurt the same exporters in the medium term when they need to go out into the world and buy raw materials for higher prices. This push and pull is what defines modern Forex on a systemic level. While average investors certainly don’t need to know this unless you’re planning on getting a job with a central bank, it can help any investor understand how and why Currency markets fluctuate the way they do. It should also be noted that these forces maintain ‘bounds’ naturally, establishing a sort of ‘high’ and ‘low’ limit for any FX pair. For example the EUR/USD now trading around 1.19, it can go in next days to 1.20 or 1.21 but not 1.90, for example. Even in rare cases such as the “Brexit” the GBP/USD went down by less than 10% – which is a lot, for a major Currency. So let it be known to all that these risks in FX are investable (with the help of algorithms) and hedgeable. Looking from a risk management perspective, it is a lot more manageable than securities, commodities, or bonds – which have the finality of the ‘ulimate’ risk (default) – as Currency is ‘money’ the Euro can’t ‘default’.

A final note to all you Bitcoiners – Bitcoin is a Currency it’s only a matter of time before it’s integrated into the Forex system, because BTC/USD is an FX pair. Good time to brush up on your FX and understand the broader market (not just the microcosm of Cryptocurrencies).